Question:
I have a question regarding restaurant asset sale and valuation. The restaurant I am interested in is valuing the business at $101,000. They are estimating the value of the lease at $50,000. The monthly lease is $1,270 and expires in August 2020. First, I do not understand how a lease as a liability is used to value the business. Second, if the lease expires in two years, why is it valued at $50,000 and not the value of the remaining lease? Finally, if the lease is not transferrable, what value is there in the current lease?
– John S. Carroll, Owner, C&C AV Rentals LLC, Plantation, Fla.
Answer:
In considering the purchase of a restaurant, there is value in the lease as part of the overall operation. Is the rent below market? Is rent well under 8% as an expense on the P&L? Is the concept in an up-and-coming area and covered under a long lease? Are contracted rent increases modest? Is it renewable at the current terms? Are favorable lease terms transferrable to a new owner? Any of those factors can make a purchase opportunity more favorable to a buyer.
That said, I thought it was unusual to see such a high value ascribed to the lease in your situation. I asked an expert, Mary Sigel, of King of Prussia, Pa.-based Sigel & Associates, who has done right by friends of mine in preparing their restaurants for sale. She says, “The current owner’s methodology for valuing their restaurant is really not valid. The most important indicator of value is the restaurant profitability. The buyer would need to see at least two to three years of P&Ls and balance sheets to assess the restaurant’s profits.The second item is the FF&E [furniture, fixtures and equipment] that would be a part of the balance sheets, and the buyer would need to assess if that is a good number. [The last question is whether] the lease is able to be transferred and also extended for a minimum of five years or two five-year terms beyond 2020 at an agreeable rate for the buyer. I have never seen a lease valued at $50,000—it is a part of the sale but does not hold value, and certainly not $50,000.”
My advice is to work locally with a third party who can dig a little deeper to evaluate the investment opportunity. Consider the lease terms as a reason to make this investment particularly attractive or to send up some warning signs, but not as such a substantial part of the value.
More on calculating the value of a restaurant here.